There are many reasons why most well-respected economists of today think inflation is not only necessary but indeed welcomed.

They argue debtors benefit directly from inflation, since their debt becomes cheaper to pay with time. However, a person could use this exact same point to argue that inflation gives people the incentive to accumulate debt instead of savings.

In this paper, we will discuss how Bitcoin’s disinflationary properties will help in tackling the wealth gap worldwide, by looking into the distant past, and how that outcome could, once more, enable the lower classes to accumulate wealth simply by hoarding currency.

Today in economics, it’s generally accepted that world economies need inflation in order to grow. The general argument made by traditional economists is that without inflation, there won’t be enough spending and thus, currency won’t circulate as much, and businesses won’t be able to survive.

Why? Because “one man’s spending is another man’s income,” as Ray Dalio explains in this iconic video.

Therefore, according to the Time-Preference Theory of Interest, economists claim that without inflation (or with deflation), people are not incentivized to spend today, since goods and services will be cheap tomorrow. Essentially, they say:

High time preference is more important than Low time preference, where time-preferences are associated with either spending today and not in the future or the opposite.

Of course, there’s a huge misconception in the argument.

Since the purchasing power of fiat currencies, namely the U.S. Dollar, keeps declining, there is no actual incentive to save up for future consumption. You already know goods and services will be more expensive tomorrow, than today, so why even bother not consuming today (high time preference).

Undoubtedly, the misconception surrounding these two, and their actual effects on economies, has led to a great deal of folk to be seduced by this high-time preference logic, meaning that they would rather spend today than tomorrow, even if that goes against their own interests. Let’s take a look at why that happens and what we can do about it.

First, we need to discuss the concepts of inflation, deflation and disinflation. These definitions are associated with the change in the prices of goods and services, and commonly linked to the rate of currency production.

What does Investopedia tell us?

“(Inflation) is the rise in the general level of prices where a unit of currency effectively buys less than it did in prior periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing power of a nation’s currency”

- Investopedia’s definition of inflation

Essentially, inflation represents the rise of prices, which dictates the overall purchasing power of a currency. Inflation is associated with, but not exclusive to, the additional number of currency units in circulation, compared to previous years. Very simply, the more currency there is in circulation, the more units you will likely need to spend to purchase the same basket of goods and services.

“Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.”

- Investopedia’s definition of deflation

According to Investopedia, deflation is exactly the other side of the coin (no pun intended). While inflation is often caused by additional units of currency being dumped into an economy, deflation is the exact opposite: it represents a general decline in the prices of goods and services, and is sometimes associated with the decreasing rate at which new units of currency enter the economy.

“Disinflation is a temporary slowing of the pace of price inflation. It is used to describe instances when the inflation rate has reduced marginally over the short term. It should not be confused with deflation, which can be harmful to the economy”

- Investopedia’s definition of disinflation

Last but not least, disinflation is the process of the inflation rate being reduced over time. A perfect example of this is what happens with bitcoin. However, even Investopedia makes the wrong assumption of thinking deflation is bad. Why? Because they assume deflation is only associated with bad economic periods, when production and output fall. Of course, that couldn’t be further from the truth, as we’ll soon discuss.

Essentially, inflation refers to the rise of prices — often due to currency printing — while deflation refers to the decrease in the price level (which is frequently related to the destruction of currency or debt). Disinflation was brilliantly discussed by QE’s own analyst, Jason Deane in this post, and it represents a temporary slowing of the pace of price inflation. That’s precisely how Bitcoin (and many other cryptocurrencies) work: by making sure fewer currency units are printed in the future than at present time.

So while inflation makes goods and services more expensive, deflation and disinflation help out in lowering general prices. Of course, all of these concepts should be applied to the price of all goods and services, meaning, while some goods (like real estate and stocks) may be inflating in price, others can be stagnant or even deflationary (like technology) during the same period.

Adding to the above, the price of goods and services going upwards and downwards, greatly influences who is benefiting the most from currency printing or debt destruction. This is, while the rich are being helped by QE measures, since central banks are buying up assets, inflating prices and enriching those who hold such assets, the poor are suffering greatly since it’s getting more expensive to purchase real estate and stock.

Undoubtedly, we already know how the song goes. If left unchecked, inflation will eventually end up affecting the prices of everyday goods, such as groceries, energy or transportation making everyone much poorer and, eventually, destroying the purchasing power of its own currency due to hyperinflation.

But if we really want to understand what could potentially be the best outcome, we should take a deep-dive into the past two centuries in order to study the inflation and deflation cycles, and how they truly affect the economy.

You might be surprised by the conclusions we’re about to find out.

Today we’re travelling further than what some may consider reasonable. But to our point, there haven’t been many deflation periods since the late 1800s, according to data provided by Measuring Worth.

As you can see below, the consumer price index (CPI) has been moving in an upwards trajectory since the mid-1800s, being the only exception to the periods between 1865–1900 and 1920–1933.

Interestingly enough, one of the longest and most prosperous periods for the U.S. economy included the 35 years in-between 1865 and 1900. During this time, things really took off. Not only did GDP increase fourfold and real wages rise over 23%, but prices of general goods and services decreased by nearly half.

You heard it here first, folks: prices halved between 1865 and 1900, while people were making more money (in real terms, nearly 75%) and GDP was skyrocketing.

So, how come we are made to think deflation is the boogeyman that will stop people from buying goods and services, since all they do is to save in order to “buy stuff tomorrow”? It is true deflationary spirals may lead to bad economic downturns. Of course, that normally happens when there’s a catastrophic event that is accompanied by lower production, lower wages, decreased demand, and lower prices.

The truth is, as long as the money supply grows at a similar pace to GDP, deflation seems to boost people into being more productive, since the inflation-adjusted value of their wages keep rising, they work fewer hours, making the economy boom.

But enough chat. Let’s check a couple of extra pretty charts, shall we?

The above chart shows the trajectory of the U.S. GDP between 1865 and 1900. What becomes rather obvious is the constant growth, between the years, with a minor gap between 1891 and 1894.

During this period, real GDP went from $119,408.00 million to $479,691.00 million, which represents a 401% increase, according to figures provided by MeasuringWorth.

Not only that, but the increase in the money supply did match the increase in GDP, as we can see on the next chart. That means there was little room for price inflation since the increase in production was increasing the money supply, unlike today where there is a clear disconnect between GDP, money supply, productivity and real wages.

Above we can see the chart for the United State’s money supply (M2) between 1867 and 1900. It went from around USCB 1,28 million in 1867 to USCB 6,6 million in 1900.

What’s interesting about that? As we argued above, the growth in the money supply seems to match the growth in GDP. If GDP increased around 401%, the money supply grew around 515%.

Additionally, if we divide the money stock by the GDP, it becomes clear that the currency was much more valuable back then. Essentially, while the ratio money supply to GDP was about 0.013 (or 1.3%), today it represents around 0.9 or 90%.

This shows that while in 1900 each unit of currency was producing 72.5 units of GDP (measured in USDC), today each unit of currency is only producing 1.2 units of GDP (measured in U.S. Dollars). In nominal terms, we’re looking at a 99.98% loss of GDP creation power, per currency unit, since 1900.

Interestingly, even with an expansion of the money supply the consumer price index, or CPI, was falling back then. Why is this point crucial to our analysis? Because it shows prices can fall, even when an economy is booming and the money supply increases.

Let’s discuss below.

While today we live in a world where inflation is king, and our hard-earned dollars are constantly being diluted by the Federal Reserve, there were (short) periods in history where the government actually did manage to make things great.

Spoiler alert: it wasn’t by destroying the purchasing power of the U.S. Dollar. It was actually by doing the opposite.

What the chart above clearly shows, is a declining trajectory of the Consumer Price Index (or CPI, for short).

Even though this indicator is constantly being manipulated, and “better” ways of measuring purchasing power are being created every year or so, it can give us a rough estimate of how prices looked between 1865 and 1900.

Since GDP was growing rapidly, shouldn’t we expect units of currency to lose value due to the increase of money supply?

Actually, no. Instead, each unit of currency was gaining value, since goods were getting cheaper. This means, you had to spend fewer Dollars to acquire the same basket of goods.

Does this seem contradictory? That’s just because we’ve all been played like fools by mainstream economists and politicians, who argue deflation is bad for economic activity, since it reduces trade.

Let us ask you this question: if you were in charge, why wouldn’t you want to print more currency if you can allocate it to yourself and your friends first, before distributing to the rest of the population?

If this was not the case, how can we explain a growing GDP per capita, while the share of the wealth keeps falling for the medium- and lower-income classes?

A straightforward example of the most substantive problem that exists due to how currency is currently distributed, explained by the Cantillon effect, that we discuss here, is the significant increase of wealth inequality between the upper-income and middle- and lower-income families.

Looking at the two images above, courtesy of the Pew Research Center, we notice how the class that has benefited the most from a better economic performance, has been the upper-income class. During the past 33 years, the wealth of the upper-income class has increased 31%, while the wealth of the middle-income class fell nearly 50%, and the wealth of the lower-Income class decreased by 42%.

At this point, the question of what drove the spread of the wealth gap must be asked.

Although you may not believe this, in our opinion, high levels of inflation seem to be the root cause of the problem, since it may lead to government bodies to become greedy and corrupt over time.

To prove our thesis, we confirm that not only public trust in government is near historic lows, but also the U.S. Corruption Perceptions Index rank, that shows countries and territories based on how corrupt their public sector is perceived to be, keeps trending to the more corrupt side, over the years.

Now, let’s get back to the first chart, the one that contains the CPI between 1865 and 1900.

What happens during periods of deflation? What the data shows is prices dropping by 51% from 1865 to 1900.

Is that really a bad thing? Essentially, in 35 years you were able to increase your wealth by 50%, only by holding currency. Crazy, right?

But wait, there’s more.

One could argue if prices decreased, that meant wages were declining. At least, that’s how most people see it: if people make more money, they can spend more, thus prices should rise.

How about… no?

What history clearly shows is a rather obvious trend: wages keep rising. Meaning, people in the late 1800s were getting a double jackpot: not only did their wages increase by 27%, but prices dropped by 51%, additional MeasuringWorth figures show. This means real wages were at least 78% higher, since money could buy 78% more worth of goods and services.

How is this possible? It’s simple math: if people were getting more money per hour worked, they simply had to work fewer hours to make as much money as they did before. Hence, people were actually getting paid more for each hour of labour!

So now you see why deflation may not be as bad as some make it out to be. Under normal circumstances, as long as productivity increases, GDP should continue to grow.

Not only that, but if governments and central banks choose to not print currency to pump the markets and/or assets (ie, not QE), GDP can still augment through time. Therefore, could we potentially paint a future where Bitcoin comes into play as a world reserve currency?

Bitcoin, regardless of how some like to paint it, is not a tool to make everything perfect, nor to make everyone rich (sorry to disappoint, folks).

The digital currency was designed to run 24/7, with a known and predicted supply, and without a central party to change the rules.

Like gold, it contains a disinflationary property, meaning that the rate at which new units are created is designed to decrease over time. Therefore, assuming demand stays constant, we should expect its price to rise (in fiat terms) over time.

Unlike gold, its supply is known and easily verifiable, but producing an additional unit is rather expensive. With these built-in game-like mechanics, Bitcoin is set to conquer the world and take it from fiat currencies.

By making long-term hodlers wealthier as time goes by, it creates a unique opportunity for people worldwide to increase the value of their holdings.

The concept described below represents the cycle of bitcoin’s distribution, and what it tells us is that, since the number of coins is limited, if you use BTC to make a purchase, you won’t get it back through bitcoin printing, that is unless you participate in the minting of new bitcoin.

In sum, if you want to use your bitcoin today, you must part with it. However, since BTC is disinflationary, it’s likely you will need to spend less of it to acquire the same goods and services over time.

Therefore, new BTC hodlers get a chance to build up savings, since even if they come in late to the bitcoin accumulation game, their holdings won’t be diluted. This means the cycle of accumulation and selling repeats until BTC gets further and further distributed among the world’s population.

What this means is that the distribution of bitcoin eventually becomes much fairer,, simply because people who do not own bitcoin can acquire some and be sure the purchasing power of their holdings won’t get diluted in the future, and the currency won’t lose value continuously (rather the opposite), as we discuss in this piece.

Let’s return to the topic at hand.

So far, we’ve seen how deflation can, in fact, help an economy grow by making products cheaper, wages higher and, overall, increase domestic production.

Therefore, we can conclude that every time we choose not to spend a dollar, we’re simply stealing from our future selves, since inflation erodes future purchasing power.

Looking at the chart above we can make a rather straightforward conclusion: we’re decreasing our future purchasing power by devaluing future currency, or the amount of goods and services it purchases.

Take real estate or stocks, for example. These markets have been highly affected by QE, as we discuss in this piece. What we conclude is a direct correlation between stock prices and QE.

As Jeff Booth, a writer and technologist, has pointed out numerous times, technology is deflationary by nature. This means it should get cheaper with time, at least by a factor equal to or similar to its efficiency increases.

However, purchasing power continues to fall which means the value of their money keeps dropping. This creates imbalances between the haves and have nots. Jeff details this issue brilliantly in this piece:

“Governments continue to fight the forces of technology-induced deflation with enormous monetary easing and negative interest rates, which pushes wealth faster to the top technology companies, worsens income inequality and keeps prices from dropping. (In some respects, rising food prices and even home prices already reflect this.) A permanent underclass of alienated, unemployed (and unemployable) people emerges and grows progressively larger. Societal unrest, large-scale protests and any number of unpleasant outcomes ensue.”

Bitcoin aims at tackling those issues. As we discussed in the previous chapter, its goal is to give hodlers the chance to accumulate wealth, by storing value in BTC for long periods of time.

Without Bitcoin, we have no easy way to store wealth digitally, and are mostly dependent on third-parties to hold our wealth for us (gold, stock), or in a legal jurisdiction to keep respecting ownership rights (real-estate).

Furthermore, savings in fiat currency make little sense due to continuous inflation. Why would one save a few bucks if those same bucks will become worthless in a short number of years?

In this piece, we’ve highlighted how deflation (or even disinflation) can lead to amazing economic outcomes, as it did happen with the U.S. between 1865 and 1900.

Today, the only currency widely available that is disinflationary is Bitcoin.

What this means is that, if we want to separate money from the state, as we discuss here, we need to move into BTC as a global reserve currency. Only by doing that can we force governments worldwide to adopt stricter monetary measures that benefit most, instead of benefiting just the few (or 1%).

If we want to build a globalized conscience that has lower-time preferences, focusing on the future instead of the present, we first need to adopt a currency with such traits.

By moving your money into Bitcoin, you’re making a powerful statement. You’re showing everyone around you your true colors. You prove you have skin in the game, and that you really care about the future, since you’re essentially foregoing today’s consumption for a higher consumption sometime in the future.

That’s the power of each bitcoin in existence: to bring us all together to a new economic paradigm where currency is simply a tool to measure, transact and store value, and not a tool to manipulate people into buying what they don’t need or can’t afford.

Do you want your money to be worth more tomorrow than it’s worth today?

#Bitcoin fixes this!

This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose.